The present invention relates to information systems and methods, and more particularly to information systems facilitating financial transactions involving escrow accounts.
Financial transactions involving escrow accounts, such as letters of credit (“LC”), are well known commercial transactions that provide a valuable service for domestic and international trade. An LC is a commercial contract between two parties (a buyer and a seller) in which one or more banks serve as trusted agents to secure and facilitate the transaction.
Tracing the steps in a typical LC illustrates how financial transactions using similarly structured escrow accounts are conducted. A typical LC involves a U.S. company (the buyer) that wants to purchase 100,000 widgets for $1 million from a supplier in Germany (the seller) on net 90-day delivery terms. Both the buyer and the seller use local U.S. and German banks. In order to fulfill the order, the seller needs to finance the raw materials and labor to produce the widgets. The seller presents a signed purchase order from the U.S. company to their local German bank to borrow $750,000. The terms of the sale provide, for example, net 90 day payment after delivery.
The German bank wants to lend the $750,000 to the German supplier, but is not confident of the creditworthiness of the U.S. company and worries that the U.S. company might change its mind and reduce the order size before delivery is made. The German bank is, however, confident that the German company can deliver the widgets. The bank informs the German supplier that unless the American company either pays 50% in advance or provides an absolutely reliable guarantee of payment and non-cancellability (either from the U.S. company or some trusted third party), the German bank cannot lend the German company the $750,000 it needs. The German company notifies the American company of the problem.
The American company in turn communicates its predicament to their local bank in the U.S. They explain that they do not want to pay the German supplier 50% in advance because they are uncertain as to the financial strength of this new supplier and have some concerns as to whether the supplier will be able to deliver on the widget contract as set forth in the purchase order. The American company then asks whether the bank might be willing to serve as a trusted intermediary to facilitate the transaction.
The American bank creates a special form of a contract called an irrevocable LC, which acts as an irrevocable promise by one bank to remit money to another party (e.g. a bank in a foreign country) under certain terms and conditions. In this example, the American bank agrees to pay the German bank $1 million 90 days after 100,000 widgets are received at a specified warehouse in New York, so long as the widgets have been inspected and approved by an independent inspector as adhering to the quality standards set forth in the purchase order.
To secure the LC, the American bank requires the American company to place $1 million in an interest-bearing escrow account at the American bank. The American company cannot withdraw this money except under certain pre-agreed circumstances, such as a release of the LC by the German bank. The American bank charges the buyer a fee for setting up the LC, typically 1% of its value. There may also be other associated charges. With an LC from a recognized and trusted American bank, the German bank is confident that so long as the widgets are delivered as promised, they are sure to get paid per the agreed-upon terms i.e. 90 days from delivery. They are also sure that should a dispute arise, a trusted, independent third party (the American bank) will seek to resolve the problem and that the money will remain in escrow until such resolution is completed. On this basis, the German bank lends $750,000 to the German supplier and commerce between two wary parties in two different countries takes place smoothly.
In some cases, the money in the escrow account which secured the LC is not paid to the seller's bank. Instead, it acts as a security bond (a form of insurance) such that if the American company does not pay the German company on time, the German bank may seek to enforce the LC and claim all or part of the money in the escrow account.
An LC often involves large multinational intermediary banks or trading companies since most smaller banks do not have direct or ongoing relationships with foreign banks. These intermediary institutions regularly sell LC services to other banks and are referred to as corresponding or agent banks.
A typical LC has the following components:    1. The terms of the sale (usually a written contract)    2. A buyer    3. The buyer's trusted financial agent (usually a bank)    4. The buyer's escrow account (or an insurance bond)    5. A seller    6. The seller's trusted financial agent (usually a bank)    7. An independent arbiter of contract fulfillment    8. Trusted banking/legal authorities for assured performance and dispute resolution1. The Terms of Sale
This is the contract that governs the transaction. It is typically fixed in advance though the price can be left open based on an agreed formula such as the prevailing price on a specified exchange at the time of delivery. Contracts set forth all of the relevant terms and conditions. They typically cannot be canceled or repudiated except under very specific conditions.
2. A Buyer
A buyer is usually the recipient of specific goods. Though LC's almost always have a specified buyer and seller, it is possible that the buyer is also a seller, for example, in a transaction where the buyer also agrees to sell something to the seller. Also, commodity barter deals blur the distinction between buyer and seller (e.g., 10,000 tons of coal are bartered for 1 million gallons of oil).
3. A Buyer's Trusted Financial Agent
This trusted agent is typically a bank, but any third party with the ability to issue a promise acceptable to the seller (or the seller's financial agent) can serve this role. For example, Japanese trading companies often issue LC's.
4. The Buyer's Escrow Account
To prevent a buyer from reneging, the buyer's financial agent usually requires that the buyer place the total face value of the LC in an inaccessible escrow account. This form of security deposit does not have to be liquid. It could be government bonds, marketable securities or any other form of value which is acceptable to the issuing bank, including a portion of the company's active credit line that is segregated and pledged as security for the LC.
5. Seller
A seller is the other major party to the transaction.
In some cases the seller is the direct beneficiary of the LC. In other cases it is the seller's financing agent.
6. A Seller's Trusted Financial Agent
This trusted agent is typically a bank, but it can be any party. Usually it is the party or parties that are financing the seller's ability to complete or deliver the contract.
7. An Independent Arbiter of Contract Fulfillment
This is the party empowered to declare that the delivery terms of the contract have been fulfilled. This party is almost always independent of all of the other parties and is trusted by all parties. There may also be more than one of these parties in any given transaction. For example, for imported meat, the product must clear customs and be approved by the U.S.D.A. as meeting its standards of quality. In some cases, where there is no significant quality component to the contract fulfillment, such as the purchase of 1,000 tons of gravel, a simple bill of lading to a seller's ship can suffice as proof of delivery.
8. Trusted Banking and Legal Authorities for Assured Performance and Dispute Resolution
The entire LC system would not function if not for the parties' mutual confidence in the reliability of the legal and banking regulatory superstructure found in industrialized countries. This superstructure assures each party to an LC that the banks or financial institutions involved will behave predictably, responsibly and expeditiously. All parties are aware that banks will follow established regulations and laws for which there are both substantial and probable penalties for willful violation. And all parties understand that there is clear legal recourse should any party act in bad faith or in a fraudulent manner.
Methods and systems currently used for these transactions are complex, expensive, and often time-consuming to set up and administer. As such, they are currently used only by companies engaged in substantial international trade. A need exists to simplify the process, reduce the associated costs, and allow individuals and small companies simple and practical access to the benefits of these transactions in both international and domestic transactions.
A buyer's flexibility in LC transactions is limited because the buyer must have a pre-established banking relationship. Thus, it is difficult to shop around or create ad hoc LC's. The buyer's bank must be willing and able to set them up, and many banks are not capable of doing so. Others will only issue certain types of LC's. Also many current systems require that the buyer, seller, and bank know the identity of the seller in order to create an LC. Moreover, the cost and fees associated with LC's are often very high, especially relative to smaller value transactions. To provide a buyer with greater flexibility in LC transactions, the buyer would prefer that banks issue LC's through any large or trusted company, such as a Fortune 500 supplier, insurance company, or investor.
Other examples of transactions involving escrow accounts include real estate escrow accounts administered by attorneys serving as trusted third parties. A seller who enters into a contract to sell real estate to a buyer will often require that the buyer demonstrate that it is capable of financing the transaction and that certain penalties or other monies (such as tax payments due) are set aside in escrow should the transaction call for the payment of such monies. Because attorneys have ongoing reputations that survive the transaction, and because attorneys are well aware of the legal ramifications of violating escrow agreements, two law firms who are unfamiliar with each other will often trust one another even if the parties they are representing do not.
Using available methods and systems for escrow transactions, it is difficult for a foreign seller to help a foreign buyer set up local banking relationships capable of supporting these transactions. The seller and the seller's bank may not have experience with these transactions and thus, even if the buyer can support its end of the transaction, the seller may not have systems compatible with the buyer's systems. Furthermore, in the current environment, banks that would like to accommodate buyers and sellers by offering these transactions may be precluded because of the need for specialized expertise or international affiliate networks.
Other examples of these accounts include numbered and anonymous, “Swiss-style” bank accounts. These accounts are not identified by name, but by number. This allows anonymity of the account's owner, although the bank typically knows the owner's identity. Numbered accounts are designed to allow access to anyone with the number, so the number serves as an unrestricted key to any holder.